Cash pooling arrangements have been under scrutiny by Swiss tax authorities for quite some time now. Typically,
challenges concern the distinction between cash pool receivables and long-term loans and/or the acceptance of interest rates applied. On 7 December 2016, the Administrative Court Zurich addressed these aspects in its judgment (SB.2016.00008).

Background

A Ltd., an operating company located in Switzerland is part of a multinational group. The group has a finance company located in the United Kingdom that is responsible for global treasury, incl. the management of the group-wide cash pool. Funds can also be deposited with the finance company for a longer term at corresponding higher interest rates.

As part of a tax audit in Switzerland, a portion of the cash pool receivable of A Ltd. was treated as a long-term loan subject to higher interest rates. The reason behind the requalification was that the cash pool receivable of A Ltd. was significantly positive over a long period. As the decision of the tax authorities was largely confirmed during the appeals process, the case was brought to the Administrative Court Zurich.

Considerations of the Administrative Court

Distinction between cash pool receivables and long-term loan receivables: In the Administrative Court’s evaluation
of a potentially necessary distinction between cash pool receivables and long-term loan receivables, the court referred to key figures for liquidity such as the quick ratio that might be used as an indicator to assess the surplus liquidity of a company. The court concluded that liquid assets exceeding minimum liquidity typically required in practice might require a conversion of a portion of the cash pool receivable into a long-term loan receivable. During the years under review A Ltd. had cash pool receivables amounting to approx. 70% (and 84%, respectively) of its total assets, which was further considered a cluster risk by the court in accordance with jurisprudence. Apart from that, A Ltd. only had very limited liquidity available outside the cash pool.

Considering overall circumstances, the court came to the conclusion that the amount of the assets invested by A Ltd. in the cash pool did not keep to the arm’s length principle. As a result, the requalification of a portion of the cash pool receivable into a mid- or long-term loan was considered correct.

The Administrative Court further made a few considerations on how the portion of the cash pool receivable to be requalified needs to be determined.

The minimum balances of the cash pool receivable at the beginning and at the end of the year can serve as a starting point as a purely retrospective assessment is not considered appropriate. In addition, a bandwidth must be considered to reflect planning uncertainty.

This bandwidth is to be determined from the average balance of the cash pool receivable and will in a further step be deducted from the minimum balance during the year. Like that, the long-term portion of the cash pool receivable is determined. However, the court did not conclude on the appropriate bandwidth or margin, i.e. it referred the case back to the lower instance to determine such margin (on a case-by-case basis).

Interest rate

For the portion of a cash pool receivable that has been requalified into long-term loan along the guidelines above, long-term interest rates need to be applied. In the case at hand, the evidence of the arm’s length nature of the interest rate that would have been available for deposits up to twelve months within the group brought forward by the taxpayer was accepted. So, the higher safe haven interest rates according to the circular of the Swiss Federal Tax Administration were not applied.

After all, this resulted in an income tax adjustment (i.e. deemed dividend) in the difference between the cash pool interest rate applied and the interest rate available for long-term deposits within the group on the requalified portion of the cash pool receivable.

Conclusion

Contrary to the expectations, the decision of the Administrative Court Zurich is not final. It is expected that the case will be taken to the Federal Supreme Court. However, it remains to be seen if and to what extend the Supreme Court will comment on the aspects above.

Considering the judgment of the Administrative Court Zurich, it is strongly recommended that multinational groups with cash pool arrangements regularly monitor the development of the cash pool receivables of Swiss entities. In case of substantially positive balances over a longer period, it might be required that a portion of the cash pool receivable is converted into a long-term loan subject to higher interest rates.

At the same time, it is of increasing importance that companies fulfill their compliance obligations and are in the possession of comprehensive transfer pricing documentation to defend the arm’s length nature of the interest rates applied.

What needs to be kept in mind is that deemed dividends to sister companies are subject to Swiss withholding taxes
of 35%. Due to the peculiarities of the Swiss withholding tax, this results in a withholding tax leakage as only a partial
reclaim of withholding taxes is available in such situations based on the applicable double tax treaty.